Could there be a repeat of the Global Financial Crisis? (guest post)

Guest post by Rikardos:

Could there be a repeat of the Global Financial Crisis?

In one word: “Yes”.

Four proposals have been made by many different commentators to ensure the Global Financial Crisis does not repeat. These are all similar to or variations of:

1)      Requiring Credit Default Swaps and other over the counter (OTC) securities to be traded on an exchange and to introduce reserve requirements. Having billions of dollars in commitments that can be held off balance sheet and with no margin is a huge risk. Even the Federal Reserve cannot be sure of the amount outstanding in these unregulated markets. The world needs to ensure that all leveraged OTC securities are properly regulated.

2)      The current standard business structure has led to board capture in many Fortune 500 and smaller companies. Many Chief Executive Officers are able to dictate to the boards of their companies what their remuneration packages should be. Salaries can now be 300+ times the average wage. There is no real justification for the salaries, especially when it becomes apparent that CEO’s do often do not understand the scale and complexity of their business (e.g. Lehman Brothers, Bear Stears, AIG and others). This combined with stock options leads CEO’s to ‘game the system’. CEO’s often take too much risk, in the expectation their institution are “too big to fail” and they will receive their bonuses and options even if their company does fail. Australia has started to take some action- if boards or CEO’s have their remuneration packages voted against at two meetings it would result in the board facing reelection at the next meeting[1], while the UK is moving towards annual reelection of directors. Companies need to be required to make better disclosure of and shareholders need to be involved more in signing off remuneration packages.

3)      The global credit rating system needs an overhaul. Having the company who needs the rating paying the rating agency led to many Credit Default Swaps, Collateralised Debt Obligations and other securities gaining a triple A rating that history has shown should never have been given. No worldwide action has been taken to change the system. The existing rating agencies, Fitch, Standard and Poors and Moody’s maintain what seems like a cozy oligopoly on ratings. There is nothing to prevent the rating agencies from rating another group of investments too highly and causing another Crisis. I’m not in favour of the proposal to make the provision of credit ratings a public good. However I am in favour of changing the remuneration of credit agencies and some sort of oversight or regulation.

4)      Reinstate the Glass Steagall Act – this law was enacted in the USA after the Great Depression to separate Investment Banking from your standard deposit taking bank. The idea was that if an Investment Bank goes under it shouldn’t cause the general public to lose faith in (and possibly cause a run on) a deposit taking bank. With the Federal Deposit Insurance Corporation insuring deposits the risks of a deposit taking was reduced, until the act was repealed and companies such as Citigroup were able to purchase Investment Banks. Now the risk is higher again, some banks are now considered too big to fail. Any bank that is too big to fail should be required to split into a deposit taking bank, an Investment Bank and divest any of their other arms. That should increase competition in banking, too.

Can the Global Financial Crisis reoccur? Yes, it can, since no-one has taken action to prevent it recurring.

Nassim Nicholas Taleb, “Fooled by Randomness”.

Gabor Steinhart, “The War for Wealth”.

Ross Garnaut & David Llewellyn-Smith, “The Great Crash of 2008”, Melbourne University Press 2009

[1] Australian Corporation Act amendment July 2011.


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